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Full text of "Description of S. 1824 (relating to reforestation expenses) and other timber taxation issues : schedule for a hearing before the Subcommittees on Taxation and Debt Management and on International Trade of the Senate Committee on Finance on November 24, 1981"

DESCRIPTION OF 5.182^1 
(RELATING TO REFORESTATION EXPENSES) 

AND OTHER TIMBER TAXATION ISSUES 



Schedule for a Hearing 
Before The 

Subcommittees on Taxation and Debt 
Management and on International Trade 

OF THE 

Senate Committee on Finance 
ON November 2^. 1981 



Prepared by the Staff 

OF THE 

Joint Committee on Taxation 

November 23. 1981 

JCX-32-81 



CONTENTS 

Page 

Introduction .... 1 

I . Sinnmary 2 

II. Description of S.1824 (Senator Packwood) : 
Amortization of Reforestation Expenses and 
Reforestation Trust Fund 3 

III. Description of Certain Timber Tax 

Shelter Syndicates 8 



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INTRODUCTION 



The Siibcommittees on Taxation and Debt Management and 
on International Trade have scheduled a joint public hearing 
for November 24, 1981, on several trade and tax issues affect- 
ing the forest products industry. This document, prepared 
in connection with that hearing, describes the tax issues 
that arise in connection with the hearing. The first part 
of this document is a summary of these tax issues. The 
second part of the document describes S.1824 (Senator Packwood) 
relating to reforestation expenses and the relevant features 
of present law. The third part of this document describes 
certain timber tax shelter syndicates that hold rights to 
cut timber on public lands . 



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I . SUMMARY 



S.1824 

Under present law, a taxpayer who makes fores tation or 
reforestation expenditures on qualified timber property may 
elect to amortize up to $10,000 ($5,000 on a separate return 
of a married person) of the expenses incurred during that 
taxable year over an 84-month period. There is no carryover 
of excess expenditures or unused limits to prior or subsequent 
taxable years. 

In S.1824, the maximum annual limit on expenditures eli- 
gible for 84-month amortization would be increased to $25,000 
($12,500 on a separate return of a married person) after 
December 31, 1981. A taxpayer who has unused amortizable 
amounts under the annual . limits going back to January 1, 19 80, 
could carry over the unused limits to subsequent taxable years 
and apply the unused amounts in addition to the then current 
maximum limitation. 

Present law includes a Reforestation Trust Fund financed 
by up to $30 million annually of revenues received from tariffs 
on imported timber products, chiefly lumber and plywood. The 
trust fund is to be used to supplem.ent congressional appropria- 
tions for reforestation and timber stock improvement in publicly 
owned national forests. Under S.18 24, timber tariff revenues 
no longer would be dedicated to this trust fund. Instead, the 
trust fund would be financed from receipts from sales of trees , 
portions of trees or forest products from Federal lands (other 
than those held in trust for any Indian tribe) and -6 5 percent 
of such sales from national forests. The $30 million limitation 
would continue to apply. 

Timber tax shelter syndicates 

Under a public timber cutting contract, a person contracts 
with the Federal or State government to cut and purchase timber 
under the jurisdiction of the government. The contract price 
for the timber is determined under a bidding system and is 
payable when the timber is cut. Most public timber cutting 
contracts do not require the payment of interest for the period 
between the contract date and the date the timber is cut. 

In some instances, the holders of public timber cutting 
contracts have assigned the right to cut timber to tax shelter 
syndicates. In these transactions, the syndicate may agree 
to pay a price for the timber that is less than the price 
specified in the public contract and to offset this through 
the payment of interest. The advantage of this syndication 
is the conversion of a capital cost (the cost of timber) into 
a deductible cost (interest) . 



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II. DESCRIPTION OF S.182 4 — SENATOR PACKWOOD 

AMORTIZATION OF REFORESTATION EXPENSES AND 
REFORESTATION TRUST FUND 

Present Law 



In 1980, the Congress enacted (Title III of P. L. 96-451) 
provisions relating to amortization of reforestation expenses 
and establishing a Reforestation Trust Fund. These provisions 
are described in more detail below. 

Amortization of reforestation expenditures 

A taxpayer may elect to amortize, over a 7-year (84-month) 
period, up to $10,000 ($5,000 on a separate return of a married 
person) of qualifying reforestation expenditures incurred during 
a taxable year in connection with qualified timber property. 
The half-year depreciation convention applies, i.e., the 84-month 
period begins on the first day of the first month of the second 
half of the taxable year in which the amortizable basis is ac- 
quired. Thus, the amortization period begins on July 1 for a 
taxpayer who uses a calendar year for tax purposes, regardless 
of whether the reforestation expenditures were incurred in 
January or December of that year. The maximum annual amortization 
deduction for qualifying expenditures incurred in any taxable 
year is $1,428.57 ($10,000 f 7) and total deductions for any 
one year under this provision will reach $10,000 only if a tax- 
payer incurs and elects to amortize the maximum $10,000 of ex- 
penditures each year over an 8-year period. The full $10,000 
deduction would be reached in the 8th year. 

The election is to be made annually on a property-by- 
property basis. However, the maximum amount of qualifying 
forestation or reforestation expenditures paid or incurred 
during a taxable year which may be amortized is $10,000 for all 
of the taxpayer's timber properties, and there is no carryover 
of excess or unused expenditures to subsequent years. For a 
taxpayer who incurs more than $10,000 in qualifying costs in 
connection with more than one qualified timber property during 
a taxable year and elects to amortize the costs attributable to 
these properties, the Secretary will prescribe regulations con- 
cerning the allocation of this amortization basis among these 
timber properties. 

With regard to a partnership, the limitation applies with 
respect to the partnership and also each partner. The amorti- 
zation deduction is allowed to an estate in the same manner as 
to an individual, and the allowable deduction must be apportioned 
between the income beneficiary and the fiduciary under regulations 
prescribed by the Secretary. 



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forth the financial condition and operating results of the 
Reforestation Trust Fund for the preceding fiscal year and 
the expected condition and results of the trust fund for the 
next year . 

The Secretary of the Treasury is authorized to invest 
trust fund proceeds, in excess of amounts needed for current 
withdrawals , in interest-bearing obligations of the United 
States or guaranteed by the United States. At the termination 
of the trust fund on September 30, 1985, unexpended amounts, 
including interest earned on invested proceeds , are to be re- 
turned to the general fund of the Treasury. The Reforestation 
Trust Fund' provisions require transfers to the trust fund for 
the period October 1, 1979, through September 30, 1985, and 
authorize appropriations from the trust fund for the period 
October 1, 1980, through September 30, 1985. 



Issues 

The first issue is whether the present law $10,000 limit 
on the amount of reforestation expenditure that can be amortized 
should be increased to a higher level, such as $25,000. 

The second issue is whether amounts that are unused under 
the limit, in any taxable year, should be carried forward to in- 
crease the limit in future years. 

The third issue is whether the source of funds for the 
Reforestation Trust Fund should be changed to sales by the 
United States of trees, portions of trees, or forest products 
from Federal lands or forests in place of receipts from tariffs 
imposed on imports of timber products, chiefly lumber and plywood. 

Explanation of the Bill 
Amortization of reforestation expenses 

Maximum amortization amount . — The bill would amend section 
194 (b) to raise the limit on the amortizable basis for reforesta- 
tion expenditures from $10,000 ($5,000 in the case of a separate 
return by a married person) to $25,000 ($12,500 in the case of a 
separate return by a married person) . 

Carryover of unus'ed limits . — Under the bill, a taxpayer 
could increase the $25,000 limit by the amount of any unused limit 
carryover from prior years. The unused limit would be the excess 
of the $25,000 limit ($12,500 on a separate return) over the 
aggregate amount of qualifying reforestation expenditures for 
which the taxpayer elects the amortization deductions allowable 
under section 194. The carryover of unused limit to any taxable 
year would be the total of unused limits from prior years reduced 
by the amount of carryovers used in prior years. 

For example, assume a calendar year taxpayer incurs $15,000, 
$10,000 and $20,000 of reforestation^ expenditures in 1983, 1984 



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Qualified timber property means a woodlot or other site, 
measuring at least an acre, located in the United States which 
contains trees in significant commercial quantities and which 
is held by the taxpayer for planting, cultivating, caring for 
or cutting down trees for sale or use in the commercial pro- 
duction of timber products. The amortizable basis is that por- 
tion of the qualified timber property that is attributable to 
reforestation expenditures. These expenditures refer to the 
direct costs incurred in connection with forestation or re- 
forestation by planting or seeding, including costs for the 
preparation of the site, for seeds or seedlings and for labor 
and tools (including depreciation of such equipment as tractors, 
trucks, tree planters, and similar machines used in planting 
or seeding) . Reforestation expenditures do not include any ex- 
penditures for which the taxpayer has been reimbursed under 
any governmental reforestation cost sharing program, unless the 
amounts reimbursed have been included in the gross income of 
the taxpayer. For any taxable year in which the amortizable 
basis of qualified timber property exceeds the limitation on 
amortization, the taxpayer must allocate the amortizable basis 
to each property as prescribed by regulation. 

Reforestation Trust Fund 

There is, under present law, a Reforestation Trust Fund, the 
funds of which are to be used to supplement congressional appro- 
priations for reforestation and timber stock improvement on 
publicly owned national forests, in order to eliminate and pre- 
vent a backlog in reforestation of the National Forest System. 
Funds for this trust fund are derived from import duties on ply- 
wood and lumber. The Secretary of the Treasury is required to 
transfer receipts from these tariffs to the Reforestation Trust 
Fund in maximum amounts of $30 million for each fiscal year 
during the six-year period from October 1, 1979, through 
September 30, 1985. Transfers to the trust fund are made at 
least quarterly and are based upon estimates made by the Secretary 
of the Treasury, with adjustments in subsequent transfers to 
reflect the amount by which earlier estimated transfers were 
over or under the amounts which were required. 

For each of the five fiscal years from fiscal year 1981 
through fiscal year 1985, appropriations have been authorized 
from the trust fund to the Secretary of Agriculture to pay esti- 
mated necessary direct costs and properly allocable administrative 
costs for reforestation and related programs (under section 3(d) (2] 
of the Forest Rangeland Resources Planning Act of 1974 (16 U.S.C. 
1601(d)(2)), but only to the extent these estimated costs exceed 
amounts appropriated out of the general fund for these purposes. 
After consulting with the .Secretary of Agriculture, the Secretary 
of the Treasury must suibmit annual reports to the Congress setting 



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and 1985, respectively, for which he elects 84-month 
amortization incurred under a $25,000 annual limit on such 
elections. As a result, he would have $30,000 of unused limit, 
for carryforward to 1986. The taxpayer could elect to amortize 
up to $55,000 of reforestation expenditures that he incurs in 
1986; the $55,000 would consist of $25,000 of current year 
(1986) qualified reforestation expenditures plus the $30,000 
carryforward of past years (1983, 1984 and 1985) unused limits. 

In any taxable year, the amount of amortizable basis that 
had been acquired would be treated as first using up the $25,000 
limit and then treated as using up carryovers of unused limits 
from prior years from the earliest taxable year first. For tax- 
able years beginning after December 31, 1979, and before 
January 1, 1982, the limit for determining the amount of unused 
amortizable basis would be $10,000 ($5,000 on a separate return). 

Technical amendment . — The bill also would correct a duplication 
of section 194 by redesignating the section entitled, "Contri- 
butions to Employer Liability Trusts" as section 196. 

Reforestation Trust Fund 

Section 2 of the bill relates to the Reforestation Trust 
Fund. Instead of the present law requirement for the transfer to 
the Trust Fund of up to $30 million from revenues attributable to 
tariffs on timber, the bill would transfer revenue received from 
timber sales and forest products on Federal lands. 

Specifically, the Secretary of Treasury would transfer up to 
$30 million to the trust fund 65 percent of the amounts received 
from sales made by the Secretary of Agriculture of trees, portions 
of trees, or forest products located on National Forest System 
lands, and all amounts received from such sales made by the 
Secretary of Interior from Federal lands (other than lands held in 
trust for any Indian tribe) . This will not effect existing 
commitments for uses of these funds- This change would apply to 
sales made after December 31, 1981. 

Effective Dates 

The amendment increasing the limit on annual additions of 
amortizable basis would apply to additions to capital account made 
after December 31, 1981. 

The amendment adding carryovers of unused ' limits would apply 
to taxable years beginning after December 31, 1979. 

The technical amendment making Code section redesignations 
would take effect on the date of enactment. 

The amendment changing the source of funding for the 
Reforestation Trust Fund would take effect on January 1, 1982. 



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Revenue Effect 



It is estimated that the tax provisions of this bill would 
reduce fiscal year budget receipts by $2 million in 1982, $5 
million in 1983, $7 million in 1984, $8 million in 1985, and 
$10 million in 1986. 



-8- 



III. DES CRIPTION OF CERTAIN TIMBER TAX SHELTER SYNDICATES 

Description 

Under a public timber cutting contract, a person contracts 
with the Federal Government (i.e., the U.S. Forest Service) 
or a State government to cut and purchase timber that is under 
the jurisdiction of such government. The contract price for 
the timber is deterinined under a bidding system. A successful 
bidder for a timber cutting contract has the right to cut 
timber at any time during the term of the contract, which 
may be for a period of four or five years. Typically, the 
successful bidder must post a bond to insure performance under 
the contract, but is not required to pay for the timber until 
it is cut. Thus, although the contract holder has an immediate 
right to cut the timber, there typically is no obligation to 
pay for the timber until it is cut. 

Under present law, a taxpayer who holds a contract right 
to cut timber for a period of more than 1 year may elect to 
treat the cutting of the timber as a sale of such timber 

(sec. 631(a)). Gain or loss on the cutting of the timber is 
the difference between the fair market value of the timber 

(as of the first day of the taxable year of cutting) and the 
adjusted basis of the timber for depletion of such timber. 
Under section 1231(b) (2), timber to which section 6 31 applies 
is treated as "property used in the trade or business;" thus, 
gain arising from the cutting of the timber is treated as capital 
gain. Gain from converting cut timber into forestry products 
is ordinary income. For a taxpayer that acquires a public 
timber cutting contract, the adjusted basis of the timber 
for purposes of depletion is based on the contract price paid 
for the timber. 

In some instances, the holders of public timber cutting 
contracts have assigned the right to cut the timber to tax 
shelter syndicates. The tax shelter syndication of public 
timber cutting rights is distinguished by the conversion of 
some of the future capital cost of timber into a present 
interest cost. In this manner, a current deduction against 
ordinary income is generated that would not have been available 
to the original contract holder. When the syndicate cuts the 
timber, the lower cost of the timber results in a realization 
of a corresponding amount of capital gain that the original 
contract holder would not have realized. 



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Typically, such a syndication would consist of investors 
as limited partners and the original contract holder as the 
general partner. The contract holder assigns to the syndicate 
the right to cut the timber that is subject to the public 
timber cutting contract. The syndicate pays the contract 
holder for the cutting rights, plus interest, and then has 
the right to cut and sell the timber. The original contract 
holder remains contractually obligated to pay for the timber 
as it is cut. The syndicate usually would be doing business 
as a limited partnerhsip, so that the losses and profits of 
the syndicate could be passed through to each of the syndicate 
members . 

The syndicate, which does business in the same way the 
original contract holder would have done business by itself, 
will generally incur the same expenses of doing business and 
will be allowed the same decutions , which will be passed 
through to the syndicate partners. However, the syndicate 
will incur the expenses of interest on the purchase of cutting 
rights which is an expense the original contract holder would 
not have incurred. Typically, this would be offset by a 
reduction in another expense, i.e., the purchase price of 
the timber. 

For example, if the original contract holder had the right 
to cut public timber at a purchase price of $105, he might sell 
the right to the syndicate for $60 plus 15-percent interest, to 
be paid when the timber is cut or at the end of the term of the 
contract. If the timber were cut after 4 years, the contract 
holder would then pay the Forest Service $105. The syndicate 
would pay the contract holder $60 plus $45 interest. For four 
years, the syndicate would have accrued total interest expenses 
of $45 that were deductible as they accrued. When the timber 
was cut, the syndicate would have a capital investment in the 
timber that was $45 less than the contract value of the timber 
and a corresponding increase in capital gain. Thus, the net 
effect with respect to the syndicate partners is to convert 
current ordinary income into future capital gain by characterizing 
part of the purchase price of timber as interest expense. Of 
course, the original contract holder would receive some additional 
consideration to reflect the value of the tax savings gained by 
the syndicate and to offset any increase in its income tax liability. 



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Issues 



The syndication of public timber cutting rights to 
investors for tax shelter purposes raises several issues 
regarding tax policy and the management of public resources. 
The system of competitive bidding for public timber cutting 
rights is intended to provide for the efficient use and 
conservation of public timber resources. The committee may 
wish to consider whether use of timber cutting contracts 
to shelter other income could lead to the uneconomic use of 
public resources. In addition, consideration could be given 
to the practive of recharacterizing part of the cost of the 
timber as an interest expense. 



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